Business owners should determine if an LLC or S corp is better for their business. For income tax purposes and management structure, choosing the right business structure will have an effect on them.

How to change LLC to S Corporation

In order for the entity to be changed from an LLC to a corporation, the business will need to file with the state agency who is in charge of corporate filings. They can help them convert to a corporation. When an LLC wants to be an S corporation instead, they will need to formally change their entity type with the formation state. At this time, they can also put in a request to change to an S corporation for tax purposes.

When converting an LLC to an S corporation, the first step is to figure out if the LLC qualifies for S corporation status. Not every corporation can be taxed as an S corporation. These are the requirements: 

  • none of the shareholders can be a corporation, non-resident alien, or partnership
  • must be a domestic corporation
  • has no more than 100 shareholders
  • has one class of stock

What is an S Corporation?

S Corporations (S corp) can be referred to as small business corporations or S subchapter. An S corporation passes corporate credit, deductions, income, and losses to each shareholder for the purposes of federal taxes. When deciding to run a business as an S corporation, know that the IRS won't officially change its organization as an LLC.

The S corporation status protects small business owners from double taxation. The IRS has a restrictive amount of ownership to the S corporation compared to LLC. Shareholders must be U.S. citizens. All shareholders must agree to the S corporation tax status. There is also C corporation (C corp), which is simply a regular form of corporation. C corporations can become S corps with certain requirements. 

LLC vs S Corp

An LLC is created for federal tax purposes under state law. LLC members pay self-employment taxes. It can be treated as a corporation, partnership, or sole proprietorship. The LLC has more advantages because there is more flexibility compared to a corporation structure. S corporations are not the same as a business entity. It is an elected tax status. S corporation status is taxed based on profits. Leftovers profits are given as dividends to shareholders which have a lower tax rate than regular income. So it is personal to convert an LLC or S corporations.

Tax Returns

You want to make sure you meet all the tax filing requirements before you file. If the entity's tax status needs to be changed, but not its structure, fill out Form 8832 and file it with the IRS. If this form is not completely filled out, the LLC will be classified under the IRS' standard rules. If the LLC changes its tax status, for example, to be taxed as a corporation, it won't be able to change its tax status again for at least 60 months. In order to be taxed as an S corporation, the LLC must file Form 2553. An LLC is not a corporation, even if the IRS recognizes it as an S corporation for tax purposes.  

If the LLC's formation state allows for the formal conversion, it's a fairly easy process. It will cost either the same or a little more than it would cost to form a new entity. Usually, a member would on be required to file the corporation's Articles of Conversion. This document will act as the Articles of Incorporation for the new business entity.

If a simple conversion process is not allowed by the formation state, the company has several choices instead. They can do the following: 

  • send the IRS a letter informing them of the structural change
  • choose to be an S corporation by filling out Form 2553
  • cancel the LLC while filing with the state for a new corporation

Wyoming, Nevada, Florida, Delaware, and California allow such conversions, but Pennsylvania, Colorado, Arizona, New York, Alabama, Connecticut, and New Jersey don't. In order to meet the IRS' requirements, the LLC must be a domestic entity that has a single class of stock. They also need to have less than 100 shareholders.

Some regulated businesses, such as international sale corporations, financial institutions, and insurance companies, cannot choose to become an S corporation. Form 8832 will show them how to classify their company instead. If the LLC has already been classified to be taxed as a corporation, Form 8832 does not need to be refiled. However, if the LLC was taxed in the past as a sole proprietorship, Form 8832 needs to be filled out and box 6a must be marked to choose corporate taxation.

If the LLC is foreign, it can't be changed into an S corporation. Form 2553 can be used to choose to be an S corporation. In order for an LLC to use its new structure in the current tax year, this form needs to be filed within two months and 15 days from the start of the tax year. If this doesn't happen, the election will begin next tax year. 

The biggest effect of choosing federal tax treatment when the company is an S corporation is no longer having self-employment tax levied on partnerships. Corporations and LLCs restrict the personal liability their owners have. However, their management and ownership structure is different.

If you need help converting an LLC to an S corporation, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.